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Continued pressure on NIM for majority of small regional banks in Q4'19 earnings

Analysts expect 2019 fourth-quarter earnings to reflect several trends seen earlier in the year — pressure on net interest margins, slower loan growth and one-off credit issues.

The Federal Reserve cut rates three times in 2019, creating a headwind for banks trying to bolster net interest margins. This pressure on NIM will weigh on profitability and earnings in the fourth quarter, said Brady Gailey, an analyst with Keefe Bruyette & Woods.

Analysts also said they expect slowing loan growth to hamper earnings. The business cycle is in its later stages, and investors may be wary of banks pursuing too much loan growth, said Kevin Fitzsimmons, an analyst with D.A. Davidson. Loan growth slowed through much of 2019, and Federal Reserve data suggests further weakness in the fourth quarter.

The age of the business cycle also raises the risk of an uptick in credit issues. For banks with $10 billion to $25 billion in total assets, analysts expect the vast majority to report sequential declines in net interest margins and linked-quarter increases in charge-offs.

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One bright spot for banks in fourth-quarter earnings is likely to be mortgage lending, both analysts said. Traditionally, mortgage lending is weaker in the fourth quarter, Gailey said, but several banks have said both traditional gain-on-sale and mortgage warehouse business is up. Fitzsimmons credited lower rates, which tend to boost refinance volume, with the increase.

Reduced rates should also give banks an opportunity to reduce funding costs, Fitzsimmons said. Most banks have reached an inflection point and should be able to start lowering funding costs, which have lagged loan yield declines, he said.

Small regional banks are likely to experience economic trends similar to larger peers. Gailey noted that banks that have recently crossed the $10 billion mark will have higher expenses and have to adjust to a cap on interchange fees, potentially driving a slight drop in profitability.

Analyst estimates show quarter-over-quarter declines in earnings per share and revenue for most publicly traded banks between $10 billion and $25 billion, but on a year-over-year basis, the estimates suggest generally higher results.

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Credit quality has been near-pristine in recent years, and analysts expect it to continue to "normalize" with some potential for one-off credit issues, as seen earlier in the year. Higher-risk categories, such as shared national credits and leveraged lending, are the most likely sources of credit problems. By sector, franchise restaurant and energy are the top candidates for deterioration, analysts said.

With the current expected credit loss, or CECL, model starting in the 2020 first quarter for many banks, more companies are expected to disclose provisioning estimates, analysts said. Most banks have been running CECL in parallel with their normal reserve metrics for years, said Gailey.

Overall, he said adoption of the accounting standard will be a "non-event" since banks have excess amounts of capital. But he said it will change how banks calculate accretable yield on acquisitions.

CECL will have less of an impact for smaller banks since they tend to have more commercial loans, which are shorter-term, Fitzsimmons said. Banks with more exposure to consumer loans will see a greater impact from CECL.

Despite margin headwinds and potential credit one-offs, Fitzsimmons said he is "cautiously optimistic" for 2019 fourth-quarter earnings. But he expects investors to be more concerned with looking ahead to 2020 as opposed to fourth-quarter trends.

"We think investors are going to be much more focused on the outlook," he said.